The India volatility index (India VIX) crossed the 21-mark on May 14 amidst the Lok Sabha polls. Anvitii Rai looks at what the VIX is, what its utility is in the stock market, and whether retail investors should be concerned about it
l What is the India VIX?
THE INDIA VOLATILITY index, in simple terms, is the rate and magnitude of change in prices of the Nifty 50 stocks over the short term and is expressed in percentage terms. It measures the short-term market volatility expectations (30 calendar days) of market participants.
The India VIX was introduced in 2008 by the National Stock Exchange. An easy way to make sense of the VIX is to remember that volatility and the VIX value move parallelly, while the India VIX and Nifty prices move inversely.
So the more Nifty50 goes down, the more the India VIX goes up. And the higher the VIX, the higher will be the risk for investors.
The VIX was first launched by the Chicago Board Options Exchange (CBOE) in 1993, and was based on the S&P 500 prices. The VIX is based on the Black & Scholes model, which was introduced in 1973 by economists Fischer Black and Myron Scholes, and economist Robert C Merton expanded on its mathematical understanding. This was instrumental in promoting options trading. Merton and Scholes received the Nobel Prize for economics in 1995, with Black mentioned as a contributor posthumously.
l How is the volatility index calculated?
THE VIX IS calculated based on the best bid prices of options. Options contracts are agreements to facilitate a potential transaction on an underlying security at a specified date and at a preset price. Thus, the VIX is based on the variance of these securities, as the price of these options reflects the markets’ expectations of future volatility. The India VIX takes four factors into account—time to expiry, calculated in minutes for precision; the NSE Mumbai Inter-Bank Offer Rate (MIBOR), which is the “interest rate that represents the rate at which banks in India borrow unsecured funds from each other in the interbank market”, according to the NSE; the forward index level, the latest available price of the concerned security; and the ask prices of out-of-the-money options contracts.
l Which factors affect the index, and what does it say about the market?
THE VIX IS also known as the fear gauge, or the fear index. Fear in the markets can be perpetrated owing to a number of factors, including anything from political unrest to natural disasters. For example, at the beginning of the Covid-19 pandemic, after the lockdown was announced in India on March 22, 2020, the India VIX soared to an all-time high of 86.63 on March 24, surpassing the historic peak of the global VIX (85.13) during the 2008 financial crisis. The VIX follows the market, so a sharp rise or fall within the markets is always preceded or followed by a spike in the VIX. The VIX causes investors to adopt measures to avert risk, the most common being hedging, which involves them taking an opposite position in a stock to the one they hold.
l What is the reason for the current surge?
THE ONGOING LOK Sabha polls are seeing a turbulent competition, with the election being charged with quite a lot of volatile undertones. The India VIX has shot up from 10.15 on April 23 to 21.88 on May 14, indicating that the pre-election confidence in the stock market has been replaced with apprehensions about the likely verdict and thereby, changes in existing government policies.
This is not new, and elections do affect the VIX. Historically, the India VIX has spiked during elections— in 2019, on May 17, it moved to 28.08, but came down to 12 after the BJP achieved a thumping victory. In 2014, it went to a high of 37.71, and in 2009, it went to 84.9, but that was also affected by the aftermath of the 2008 financial crisis. This is a trend that is also seen globally, as the CBOE VIX went up to 38.5 in 2020, which was also coupled with effects of the pandemic.
l Should retail investors be worried?
THE VIX, WHILE a good measure of volatility and the state of the market, is mainly a tool for intra-day traders. It is certainly wise for investors to keep themselves informed of the markets, but experts say that retail investors should not panic, and continue with their asset allocation strategy instead of engaging in immediate risk aversion measures. Rather, the dips in the market offer an opportunity to do some stock-picking.
Normally, the India VIX stays in the 15-35 range, and a range of 13-19 is considered to be safe. However, precedent also dictates that periods of volatility have not lasted long. As Fidelity International states on its website, “While most markets will experience periods of short-term volatility, over the long-term they generally maintain a steady, upwards path. And those investors who remain invested will benefit the most from these long-term upward trends.”